This article highlights three lesser-known CARES Act tools to consider when making financial decisions in 2020.
Executive Summary
In response to the global COVID-19 crisis, the United States government rolled out the CARES Act to help stimulate the economy and keep Americans afloat as we navigate our shut down nation. While the areas of the CARES Act that have received the most attention understandably have been the Federal Stimulus checks, PPP Loans for small businesses, and expanded unemployment benefits, the CARES Act also contains a handful of updates to the tax code. Today we will outline three under-the-radar CARES Act financial planning opportunities to consider as we make decisions in 2020. We’ll start by looking at the elimination of the Required Minimum Distribution needed for retirees over age 70 ½ (and in some cases 72), then look at an update on student loans, and end with the return of a tax benefit for charitable contributions for the average tax payer, although it is a small one. We hope you enjoy this month’s edition of Quantum Insights.
The Elimination of RMDs for 2020
Required Minimum Distributions (RMDs) apply to retirement account owners that have reached the magic age of 70 ½, or more recently due to tax law changes, the age of 72. Just as we saw in the real estate and financial crisis of 2008-2009, the IRS has eliminated the need to withdraw RMDs from retirement accounts for the 2020 tax year. This allows account owners to preserve their shares and not liquidate investments while the stock market is down. If account owners still need funds to live on, they still have full access to their account, but have now been granted the additional flexibility to reduce withdrawals for 2020 if they are not necessary.
Along with not needing to sell shares in a down market, the elimination of the RMD can have a considerable impact on an individual’s tax situation. Every dollar withdrawn from a traditional individual retirement account is taxable to the account owner. With the newly announced flexibility to limit withdrawals from retirement accounts to zero, individuals can in some cases meaningfully reduce their tax bill by obtaining their income from other sources such as cash on hand, or a non-retirement investment account. Although everyone’s situation is different, this flexibility should be considered in every financial plan.
The domino effect of eliminating IRA withdrawals reduces taxable income, which leads us to the partial Roth IRA conversion. A partial Roth IRA conversion allows an individual to convert a portion of their traditional IRA to a Roth IRA, which benefits from tax-free growth. This means that the funds are transferred from a tax-deferred IRA to a tax-free Roth IRA, and constitutes a taxable event at the time of conversion. But didn’t we just review the benefits of avoiding taxable events? Yes, but by avoiding a RMD we have potentially created space within the lower tax brackets for an individual allowing for the Roth IRA conversion to occur at a lower tax rate than in a normal tax year. Again, everyone’s situation is different, but the elimination of the RMD for 2020 opens of the potential opportunity of adding to the tax-free growth a Roth IRA provides.
All Federal Student Loan Payments and Interest Paused
In a time when total student loan debt has now surpassed credit card debt in our nation, the CARES Act has put a pause on all federal student loan payments and interest until September 30th. Whether it is a grandchild or your own personal student loan, it seems most everyone knows of a situation where this will affect a loved one. So what should you do with the freed up cash flow experienced from student loan relief? Follow our checklist below:
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Cover your living expenses – If you have been negatively impacted financially by the COVID-19 crisis, use these funds for living expenses and keep from accruing more debt to stay afloat.
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Emergency Fund – Our rule of thumb is to have 3-6 months of living expenses available in cash. Use these extra funds to beef up your emergency fund.
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Pay down your loans faster – If you are in a situation where you can still make the payments, do it! Now that each individual minimum payment is not required, target the highest interest rate loans first, as most loans have different rates based on a variety of factors.
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Invest for the future – If all of the above are taken care of, now is the time to consider investing for the future. There are many different ways to achieve this, but a few options could be a Roth IRA, Health Savings Account, or increasing your contribution to an employer sponsored plan.
Charitable Contributions Deductible Above the Line (at least a little bit)
Since the dramatic increase to the standard deduction that was enacted in 2017, many Americans have been unable to deduct their charitable expenses by itemizing on their taxes. The hurdle to exceed the standard deduction for 2020 is set at $24,800 for a married couple filing jointly, leaving 88% of tax payers claiming the standard deduction. Previously, when the standard deduction was roughly half the current amount, a larger number of tax payers were able to lump together a combination of eligible itemized deductions such as mortgage interest, state and local taxes, and medical expenses along with their charitable contributions to surpass the standard deduction. Enter the new $300 above the line deduction.
In stark contrast with the historical method of deducting charitable contributions, the new $300 deduction is available only to filers that are in fact taking the standard deduction. This allows a significant portion of filers who were previously reporting their charitable contributions and having zero tax benefit to now experience an (admittedly small) tax benefit. For reference, a married couple filing jointly with a taxable income of $150,000 claiming the new $300 charitable deduction could experience a $66 reduction to their overall tax bill for the year.
Several caveats to the new rule mandate that to be eligible the donation must be made in cash and cannot be made to a donor advised fund.
In summary, for those who have given up on reporting charitable contributions on their tax return as they had previously no benefit to a majority of fillers, be sure to report them when filing next year’s taxes to take advantage of your $300 deduction!
